Weighing up pros and cons of Mighty River Power prospectus

The offer opens on April 15 and all NZ applications are guaranteed a minimum of $2000 worth of shares although they can apply for a minimum $1000 amount of shares. Photo / File

The long-awaited Mighty River Power prospectus is finally available.

The 256-page document should contain enough information for everyone, from those wanting just a brief overview of the risks associated with investing in the company to analysts who want detailed financial information.

The offer opens on Monday, April 15 and all New Zealand applications are guaranteed a minimum of $2000 worth of shares although they can apply for a minimum $1000 amount of shares.

A New Zealand applicant is an individual, company, trust or any other legal entity that is incorporated in the country and has a valid New Zealand IRD number, bank account and address.

The applicant must also confirm it is not acting for the account or benefit of a person in the United States.

Thus investors can apply for shares through any of the entities listed above as long as they meet the IRD, bank account and address criteria.

Every domestic application is guaranteed a minimum of $2000 worth of shares and if the issue is over subscribed, and applications have to be scaled back, investors who pre-registered "will receive an amount of shares which is 25 per cent higher than a New Zealand applicant who applied for the same amount of shares but did not pre-register".

One of the more important features of the issue is that retail applicants must apply for a dollar value of shares rather than a specific number of shares because the IPO price won't be set until after the retail offer closes on May 3.

These applications can be made online, through an application form contained in the prospectus or by way of a broker firm offer.

The bookbuild is a process whereby institutions may bid for shares at specific prices either above, within or below the prospectus price range of $2.35 to $2.80 a share.

The Crown sets the IPO price after the completion of the bookbuild.

There is no assurance that participants in the institutional bookbuild will receive any shares or the number of shares they bid for. Institutional allocations will be influenced by factors "such as whether the participant is a New Zealand institution managing significant investments on behalf of New Zealanders (including KiwiSaver or superannuation) or a participant representing collective interests such as Maori trusts".

Retail applicants will be allocated shares by dividing the dollar value of shares applied for, subject to scaling, by the IPO price.

This process is a clear disadvantage to retail applications because they do not know the IPO price when they apply for, and pay for, their shares and the top indicative price of $2.80 a share is relatively expensive.

As far as Contact Energy's 1999 IPO was concerned the IPO price was $3.10 a share, compared with the indicative range of $2.40 to $3, because of the overwhelming demand for shares.

The same could happen with Mighty River Power but retail investors cannot withdraw their application if the final price is higher than they want to pay.

Another important feature of the Mighty River Power issue is the loyalty bonus share scheme whereby all New Zealand applicants - individuals, companies and trusts - will receive one bonus share for every 25 shares issued under the IPO.

The bonus shares will only apply to shares continuously held from the IPO to May 14, 2015 and is limited to a maximum of 200 bonus shares.

These bonus shares will come from the Crown and will not be new shares issued by the company.

A table on page 224 of the prospectus illustrates the benefits of the loyalty bonus share scheme which may encourage investors to hold their shares for the required two years.

However, the decision to hold or sell will ultimately be determined by the company's profitability, dividend yield and industry issues, including the potential closure of the Tiwai Pt aluminium smelter.

The Tiwai Pt issue is covered under the "What are the Risks?" section on page 87 of the prospectus.

The aluminium smelter is owned and operated by New Zealand Aluminium Smelters (NZAS), which is majority-owned by Rio Tinto.

The Mighty River Power prospectus has this to say about the Bluff smelter: "[It is] the largest single user of electricity in New Zealand accounting for 13 per cent of electricity demand in 2012. NZAS reduced its electricity consumption in 2012 by 9 per cent and announced in August 2012 that low prices for aluminium produced at Tiwai Pt smelter were causing it to review its operations and to work with its key suppliers and stakeholders to reduce costs."

It concludes: "If NZAS makes a further significant reduction in electricity consumption, whether as a result of the closure of the smelter following any review or for any other reason, the resultant drop in demand could lead to sustained reduction in electricity prices in general."

Tiwai Pt is a crucial issue for the electricity generation industry but it is important to note the current three-year contract between Meridian Energy and NZAS does not expire until January 1, 2016.

NZAS then has the option to ramp down production over 2.5 years to close the smelter by June 30, 2018.

Thus NZAS must pay for its contracted electricity up to January 2016 and must continue to pay for electricity, albeit on a reducing scale, up to June 2018 if it decided to give the 2.5 years ramp-down notice.

These contractual electricity purchase obligations remain even if NZAS decides to close the smelter at an earlier date.

The take or pay agreement between NZAS and Meridian Energy gives the electricity generation industry time to adjust to the potential closure of the Tiwai Pt smelter.

Mighty River Power is forecasting net earnings after tax of $94.8 million for the June 2013 year and $160.4 million for the June 2014 year. This compares with net earnings of $67.7 million for the 2011/12 year.

This places the company on a prospective 2014 price/earnings (P/E) ratio of between 20.5 and 24.4 for the 2013/14 year at the indicative IPO price of between $2.35 and $2.80 a share. This compares with prospective P/E ratios of 19 for Contact Energy and 18.9 for TrustPower for the 2014 year.

However, the prospective dividend yield is probably more important to many investors because New Zealanders currently have $112.7 billion in bank deposits and the major banks are offering gross interest rates of no more than 4.2 per cent on one year term deposits.

Mighty River Power is forecasting a gross dividend yield between 7.1 per cent and 6 per cent for the June 2013 year and between 7.7 per cent and 6.4 per cent for the following year at the indicative IPO price range.

These figures are directly comparable with the dividend yield column in the Business Herald share table and gross bank interest rates of 4.2 per cent for one year term deposits.

By comparison, Contact Energy has forecast gross dividend yields of 5.9 per cent and 6.6 per cent, and TrustPower of 7.3 per cent and 7.3 per cent, for the 2013 and 2014 years respectively.

Although Mighty River Power's prospective gross yields are higher than bank deposits it is important to remember that shares are far more risky than interest-bearing deposits at the four major trading banks.

With this in mind it is extremely important that all potential Mighty River Power investors read the "What are the risks?" section on pages 83 to 94 of the company's prospectus.

Shares are risky and Contact Energy shareholders have had their fair share of ups and downs, even though the company has delivered total returns (capital plus dividends) in excess of 10 per cent per annum since listing in 1999.

Brian Gaynor is an executive director of Milford Asset Management which will be participating in the Mighty River Power bookbuild process. Milford holds Contact Energy and TrustPower shares on behalf of clients.